Interest rate will fall to 1% and Australian dollar will drop sharply, economist warns

AUD falls

Australia’s cash rate will fall to 1% this year and the dollar will drop sharply thanks to factors including falling Chinese demand for Australian property and Donald Trump’s presidency, a leading economist has warned.

Despite a bounce in growth in the last quarter of 2016 and a surge in commodity prices, the Australian economy will face stronger headwinds in 2017, forcing the Reserve Bank to reduce borrowing costs, according to Paul Dales, chief Australia and New Zealand economist for Capital Economics.

Speaking at the consultancy’s annual conference in Sydney, Dales said a forecast slowdown in the Chinese economy this year would reverse the recent surge in commodity prices, in turn affecting demand for Australian housing and prices.

“The housing market won’t support GDP as much as in recent years,” he said, arguing the RBA had overestimated the strength of the economy. Far from some market expectations of a rate rise this year, he said governor Philip Lowe would have to cut the cash rate from 1.5% to as low as 1% to keep inflation above its 2% target.

“The RBA won’t raise rates in 2017 or likely in 2018, and I wouldn’t be putting much money on a hike in 2019 either. In fact, with the housing market slowing, the labour market weakening and inflation staying below target it’s possible that there will be cuts this year to 1%.

“We also think the Australian dollar could fall from US77c today to around US65c because of RBA rate cuts, a stronger US dollar [thanks to Trump’s expansionary plans for the world’s biggest economy] and falling commodity prices.”

Australia’s terms of trade improved by 20% in 2016, Dales said, encouraging the RBA to forecast a doubling of wage growth from its current all-time low of below 2%

This was based on the expectation that the 20% surge in corporate profitability recorded in the last quarter of 2016 would trickle back into the economy. But Dales argued that spare capacity, excess labour supply and the pressure on mining companies to return profits to shareholders would see the benefits flood overseas.

At the same time, Capital Economics saw a weakening in the Chinese economy in 2017 as last year’s huge monetary stimulus wore off and the government increased its efforts to rein in a years-long credit binge that has seen total debt balloon to almost 250% of GDP.

The implications for Australia were important, he said, especially in the property market which has continued to defy expectations of a slowdown by posting double- figure price rises in Sydney and Melbourne last year.

“It can’t go on much longer,” said Dales. “The banks are tightening lending and raising mortgage rates so the market will slow down.”

It was difficult to measure the impact of overseas demand for Australian housing, he said, but it accounted for 20% of the value of all tranactions in the financial year 2014/15. Chinese purchases were a “big chunk” of that figure and had been boosted by a sharp fall in the yuan relative to the dollar in that period which meant the price of Australian property fell in yuan terms.

But the recent recovery of the yuan had made Australian property 16% more expensive to Chinese buyers and, combined with a tightening of lending standards and higher mortgage rates from banks, would curb prices.

Capital’s China economist, Julian Evans-Pritchard, told the audience that the crackdown on the amount of cash people could take out of the country would also have a significant impact.

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